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PetMed Express, Inc. (NASDAQ:PETS)

F4Q08 Earnings Call

May 12, 2008 8:30 am ET

Executives

Bruce S. Rosenbloom - Chief Financial Officer

Mendo Akdag – President and Chief Executive Officer

Analysts

Julie Johnson - Piper Jaffray

Anthony Lebiedzinski - Sidoti & Co.

[Kama Kava] - Canaccord Adams

Michael Friedman - Noble Financial Group

Edward Woo - Wedbush Morgan Securities Inc.

Kristine Koerber - JMP Securities

Paul Taylor - Taylor Investment Services

Operator

Welcome to the PetMed Express, Inc. D/B/A 1-800-PETMEDS conference call to review the financial results for the fourth fiscal quarter and fiscal year ended on March 31, 2008. (Operator Instructions)

Founded in 1996, 1-800-PETMEDS is America's largest pet pharmacy, delivering prescription and nonprescription pet medications and other health products for dogs, cats and horses direct to the consumer. 1-800-PETMEDS markets its products through national television, online and direct mail advertising campaigns which direct consumers to order by phone or on the Internet and aim to increase the recognition of the 1-800-PETMEDS brand name. 1-800-PETMEDS provides an attractive alternative for obtaining pet medications in terms of convenience, price, ease of ordering and rapid home delivery.

At this time I would like to turn the call over to the company's Chief Financial Officer, Bruce Rosenbloom

Bruce S. Rosenbloom

Before I turn the call over to Mendo Akdag, our Chief Executive Officer and President, I would like to remind everyone that the first portion of this conference call will be listen only until the question-and-answer session, which will be later in the call.

Also, certain information that will be included in this press conference may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 or the Securities and Exchange Commission and may involve a number of risks and uncertainties. These statements are based on our belief as well as assumptions we have used based upon information currently available to us.

Because these statements reflect our current views concerning future events, these statements involve risks and uncertainties. Actual future results may vary significantly based on a number of factors that may cause the actual results or events to be materially different from future results, performance or achievements expressed or implied by these statements. We have identified various risk factors associated with our operations in our most recent annual report and other filings with the Securities and Exchange Commission.

Now let me introduce today's speaker, Mendo Akdag, Chief Executive Officer and President of 1-800-PETMEDS.

Mendo Akdag

Today we'll review the highlights of our financial results. We will compare our fourth fiscal quarter and the fiscal year ended or March 31, 2008 to last year's quarter and fiscal year ended on March 31, 2007.

For the fourth fiscal quarter ended on March 31, 2008, sales were $40.4 million compared to sales of $36.4 million for the same period the prior year, an increase of 11%. For the fiscal year ended on March 31, 2008, sales were $188.3 million compared to $162.2 million for the prior fiscal year, an increase of 16%. The increase was primarily due to increased retail reorders for the quarter, and increased retail reorders and new orders for the fiscal year.

For the fourth fiscal quarter, net income was $4.9 million or $0.20 diluted per share compared to $3.6 million or $0.15 diluted per share for the same quarter the prior year, an increase to net income of 35%. For the fiscal year net income was $20 million or $0.82 diluted per share compared to $14.4 million or $0.60 diluted per share a year ago, an increase to net income of 39%.

Retail reorder sales increased by 17% to $31 million for the quarter compared to reorder sales of $26.4 million for the same quarter the prior year. For the fiscal year the reorder sales increased by 22% to $134.3 million compared to $110.5 million for the prior year. Retail and [new order] sales decreased by 5% to $9.4 million for the quarter compared to $9.9 million for the same period the prior year. For the fiscal year the new order sales increased by 5% to $53.8 million compared to $51.1 million for the prior year.

We acquired approximately 126,000 new customers in our fourth fiscal quarter compared to [132,000] for the same period the prior year, and we acquired approximately 710,000 new customers in the fiscal year compared to 681,000 for the prior year.

Our average retail order was approximately $81 for the quarter and $80 for the fiscal year.

Approximately 65% of our sales were generated on our website for the fiscal year compared to 62% for the prior fiscal year.

Our Internet sales increased by 13% to $26.5 million for the quarter compared to Internet sales of $23.5 million for the same quarter the prior year. For the fiscal year Internet sales increased by 21% to $122.5 million compared to $100.9 million for the same period last year.

The seasonality in our business is due to the proportion of flea, tick and heartworm medications in our product mix. Spring and summer and considered peak season, with fall and winter being the off season.

For the fourth fiscal quarter, our gross profit as a percent of sales was 41.3% compared to 40.5% for the same period a year ago. For the fiscal year, our gross profit as a percent of sales was 39.4% compared to 39.8% for the prior year. The percent increase for the quarter can mainly be attributed to a shift in product mix to higher margin items. The percent decrease for the fiscal year can mainly be attributed to increased product and trade costs offset by a shift in product mix to higher margin items.

Our general and administrative expenses as a percent of sales were 12% for the quarter compared to 12.4% for the same quarter the prior year. And for the fiscal year, the G&A was 10.8% compared to 10.6% for the prior year. The improvement for the quarter shows leverage of the G&A.

For the fiscal year, the adaption of [inaudible] during the June quarter resulted in approximately $386,000 of onetime uncollected sales tax expense in a state where for tax purposes it was determined that the company had established nexus.

For the quarter, we spent about the same $4.5 million for advertising as we did the same quarter the prior year. And for the fiscal year we spent approximately the same, $25.2 million in advertising, as we did the prior fiscal year. Advertising cost of acquiring a customer for the quarter was approximately $36 compared to $34 for the same quarter the prior year, and for the fiscal year it was $36 compared to $37 for the same period a year ago.

Our working capital decreased by $11.8 million to $38.8 million since March 31, 2007. The decrease can mainly be attributed to utilization reclassification of $24.7 million of auction rate municipal securities from temporary investments to long-term investments due to lack of market liquidity and the repurchase of approximately $11.6 million of our stock under our stock buyback plan offset by cash flow generated from operations and the exercise of stock options.

We had $25 million in cash and temporary investments, $24.7 million in long-term auction rate securities investments, and $17.9 million in inventory with no debt as of March 31, 2008.

Net cash from operations for the fiscal year was $19.4 million compared to net cash from operations of $16.6 million for the prior fiscal year, an increase of $2.8 million.

In accordance with our share repurchase program, we repurchased approximately 583,000 shares, paying approximately $6.7 million during the quarter, and for the fiscal year we repurchased approximately 952,000 shares, paying approximately $11.6 million.

Capital expenditures for the fiscal year were approximately $500,000.

Overall, we had a highly profitable year which can be attributed to increased reorders and our success in leveraging operating expenses.

This ends the financial review. We are ready to take questions.

Questions-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Julie Johnson – Piper Jaffray.

Julie JohnsonPiper Jaffray

Can you comment or provide an update on your outlook for the advertising environment as we move into the political campaign season?

Mendo Akdag

The heaviest impact we think will be in September and October for the political season. I would say there probably was some impact in the March quarter. There was a larger base of advertisers, also impacted by primaries compared to last year. So we spent less on TV in the March quarter than what we planned on spending.

Julie Johnson - Piper Jaffray

And would you plan on spending less on television advertising through the fall quarter as well?

Mendo Akdag

April was pretty well, so we cleared pretty well in April. But it's difficult to tell. We were able to spend more money in April, so I don't know if that's any indication. Obviously, that could change.

Julie Johnson - Piper Jaffray

On your large cash position, could you provide an update on your thoughts in terms of share repurchasing?

Mendo Akdag

We spent I believe about $11.6 million so far, so we have about $8.4 million left on our stock buyback plan so we plan on using that at this time. At this time, we don't have any other plans.

Julie Johnson - Piper Jaffray

Can you discuss what you're seeing in your business as it relates to a challenging economic backdrop?

Mendo Akdag

The March quarter was a little soft. The weather might have played a role. Other than that, we are probably, I'm not going to say real immune from recession, but probably we're in a recession-resistant industry.

Operator

Your next question comes from Anthony Lebiedzinski - Sidoti & Co.

Anthony Lebiedzinski - Sidoti & Co.

You mentioned that the weather had somewhat of an impact. Can you perhaps give us some more color on that? And also did you see any changes in terms of sales by region versus last year?

Mendo Akdag

I believe January and March were colder this year compared to last year. February was probably somewhat about the same. So overall the industry was soft. We were not the only ones at this point. Our guess is that the weather might have played a role in it.

Anthony Lebiedzinski - Sidoti & Co.

In terms of sales by region, anything you can comment there?

Mendo Akdag

Always in off-season, the southern states we have a lot higher sales than northern states. That was still the case this year.

Anthony Lebiedzinski - Sidoti & Co.

And also you mentioned that the gross margin benefited from a mix shift. Can you give us some examples of some of these higher-margin items that drove the increase in the gross margin?

Mendo Akdag

Due to competitive reasons, I'd prefer not to get into the details of that.

Anthony Lebiedzinski - Sidoti & Co.

You mentioned in the release here that you're adding another 15,000 in square footage. What's the incremental CapEx and rent expense that we should expect for this?

Bruce S. Rosenbloom

Initially, before our extension, we were forecasting about $520,000 of rent expense for 2009. That goes up to $641,000 and then it will increase approximately, 4% or 5% after that.

Anthony Lebiedzinski - Sidoti & Co.

And is there any CapEx that you're going to be putting into this?

Bruce S. Rosenbloom

We are, but we're in the middle of planning it so we don't have solid numbers really to report at this time.

Operator

Your next question comes from [Kama Kava] - Canaccord Adams.

[Kama Kava] - Canaccord Adams

So I'm looking at the new customers in the March quarter, and it looks like they're down year-over-year 5% approximately. I know reorder sales were up, but it also looks like customer acquisition costs were up. Can you just give us some color as to what's going on there? Was that expected or are you targeting a different kind of customer? How can we look at that?

Mendo Akdag

We did not spend on TV as much as we planned spending in the March quarter. The inventory was tight in the March quarter. The larger base of advertisers also impacted that. And we paid really a higher cost, we had a higher cost of advertising in the March quarter, so that impacted that. So we were not able to spend more in the March quarter in one reason, and the second reason is the higher cost of advertising.

[Kama Kava] - Canaccord Adams

And is there a concern that today's new customers are tomorrow's reorder customers? Are you still planning maybe to pay up a little bit for some advertising even if inventory's tight or has your view changed on that?

Mendo Akdag

Yes, we are willing to pay a little bit more to get new customers.

[Kama Kava] - Canaccord Adams

And then as far as the state sales taxes, I'm not sure if you mentioned the state that was associated with that, but are you seeing pressure in any other states yet or how can we view your exposure to potential sales tax issues going forward?

Mendo Akdag

That was really a nexus issue. We had presence in that state, that's why.

[Kama Kava] - Canaccord Adams

Which state was that? Could you mention the state?

Mendo Akdag

Yes, Georgia.

[Kama Kava] - Canaccord Adams

And then on the new website, it looks like the website was redone. Can you talk about the improvements there, how the new hook's been faring in terms of organic search or natural search, and then can you talk about some of the metrics tied to improvements in the business related to the new website?

Mendo Akdag

We have a new platform, so we launched that. Probably it was late February. And it's still a work in progress, so as far as metrics I'd rather not give any at this time.

[Kama Kava] - Canaccord Adams

I know wholesale is tiny, but can you break out wholesale versus new order sales, both for the quarter and for the year?

Mendo Akdag

Quarter it was really minimal, wholesale, $44,000 for the quarter wholesale. And for year it was $220,000 roughly.

[Kama Kava] - Canaccord Adams

Back to the website a little bit, I know you had talked about adding some personalization features. Is there any early insight into how that's impacting reorders or conversions?

Mendo Akdag

We already had some personalization so this is nothing new. This is just improving upon what we've got.

[Kama Kava] - Canaccord Adams

Are you seeing any keyword inflation [through] your vertical and then if you are seeing it and keywords and TV advertising are both looking high, what are you most effective marketing means right now to reach new customers?

Mendo Akdag

Well, it's really multi-channel marketing so it's difficult to point out whether it's TV. TV drives, for example, keyword searches, so I'm not going to break it up. But there are certain advertisings that are most efficient and what we do is we maximize that then you look at the other channels. [Online], there are certain portions [online] that are most efficient, but there are also some TV stations that are very efficient. So it's really a multi-channel approach.

[Kama Kava] - Canaccord Adams

So were you seeing keyword pricing go up?

Mendo Akdag

Yes, the cost is higher. Obviously, we control how much we are willing to pay, and we're going to pay what we can afford.

[Kama Kava] - Canaccord Adams

Gross margins look like they improved. Can you talk about transportation and product costs? I know you had some upfront purchases last quarter that may have helped. Can you talk a little about that?

Mendo Akdag

Yes, the quarter is, well, its off-peak season. Typically, there's less competition and there was a shift to higher margin products during the quarter. But if you look at the year, we went down. Actually, gross margin decreased by 40 basis points and that's made up of increase in product costs and freight costs offset by the shift to higher margin products.

Operator

Your next question comes from Michael Friedman - Noble Financial Group.

Michael Friedman - Noble Financial Group

On the gross profit margin, so this higher margin shift happened. Is this something that you think the company had a hand in or is this sustainable? Can you give us a little color on that?

Mendo Akdag

Off-peak season it's going to fluctuate, so we attempt to maximize the gross profit dollars. We really do not pay a lot of attention to gross profit percent. But peak season, the market is more competitive. So to maximize gross profit dollars we're going to be more aggressive price-wise.

So that was pretty high. It was impressive, the March quarter, but I don't expect to attain that during the peak season. I anticipate the gross profit percent to go down.

Michael Friedman - Noble Financial Group

But did that just naturally happen or did the new advertising campaigns or did anything have an impact to shift that or it just happened through the consumer?

Mendo Akdag

We had a high inventory level in December, at the end of December, and obviously we bought before the prices went up compared to last year. So that had a positive impact on it. The second impact is really the shift to the higher margin items. [inaudible] there's less competition.

Michael Friedman - Noble Financial Group

And then talking about competition, do you sense that the vets are becoming more aggressive or is there anybody else out there that you feel has really stepped up their campaign against you?

Mendo Akdag

Probably so far this year it's about the same as last year, I would say. The market is competitive and there are more players entering we notice every day. So it's a competitive market.

Michael Friedman - Noble Financial Group

And you'd mentioned we'd talked a little bit about freight costs. The consumer, are they becoming more price competitive as well? And the two of those together, will that pressure your margin?

Mendo Akdag

There are different consumers. There are different segments. Some of the consumers are price sensitive, some are not. Some are more focused on the service. So really the ideal is personalization and segmenting it properly and addressing each segment properly. If they're price sensitive, obviously we need to address that. And if their focus is service, we need to address that. At the end of the day, we need to differentiate ourselves as better service.

Michael Friedman - Noble Financial Group

But in general, conceptualizing the business is it correct to think that the consumer generally will be more price sensitive, the competitors are probably focused a little bit on that? And you would assume freight costs will probably increase a little bit in the fiscal year? Is that fair?

Mendo Akdag

Again, it depends on what segment of the customers you're talking about. Some customers are not price sensitive. They're focused on the service - if you service them well, they're not going to [inaudible] you for a couple dollars.

Michael Friedman - Noble Financial Group

And you've had some early indications as to the advertising environment in general. You've been through the cycle before. Any surprises so far?

Mendo Akdag

In April the inventory, TV inventory, was not tight so we were able to clear. So that was a pleasant surprise. That doesn't mean that's not going to change, though.

Michael Friedman - Noble Financial Group

But early indications seem to be slightly more favorable. I'm reading between the lines.

Mendo Akdag

We are able to clear. We're paying a little bit more, but we were able to clear what we wanted to clear in April compared to last year.

Michael Friedman - Noble Financial Group

And then looking at your advertising spend, obviously we're talking about a potentially tight period of time for the advertising space. If you're able to clear everything you'd like, do you have a sense for whether you could hold it year-over-year at the same pace like you did recently or do you expect to spend a little bit more?

Mendo Akdag

Dollar-wise we'd like to spend a little bit more, and that's what we attempt to do if we are able to.

Michael Friedman - Noble Financial Group

And then one last question. You talked about Internet sales. Those are creeping up a little bit. Can you just discuss the financial impact a little bit when a customer orders over the telephone versus ordering through the Internet? Is there a big gain there for the company, one way or the other?

Mendo Akdag

Obviously it's more efficient. Having said that, don't think that Internet customer is service free. They e-mail us. We have live chats. They call us anyway although they order from the Internet. So it is really not service free.

We don't look at it as shifting the customer. We are giving every channel to the customer so if they want to buy from the Internet, we've got it. If they want to call us and order, we'll be happy to take their order. If they want to fax us, if they want to mail us, if they want to e-mail their order, we're going to take it. So the consumer really calls the shots on that.

There is some efficiency obviously if they order on the Internet but it's not totally service free as we theoretically think.

Michael Friedman - Noble Financial Group

Can you comment on your new advertising campaign on TV? How's that been received? Can you give us any feedback on that?

Mendo Akdag

It's doing okay, so we don't have complaints. Obviously, we're running it. We have other creatives also. That we're running it means that we're satisfied with the results.

Operator

Your next question comes from Edward Woo - Wedbush Morgan Securities Inc.

Edward Woo - Wedbush Morgan Securities Inc.

Going back to the increasing freight cost for the year, do you think that's going to be impacting you this year as well? You hear a lot about what prices and what not.

Mendo Akdag

Yes, it will be impacting us this year, too. And we are going to have to make a decision as to maybe pass it to the consumers, some of the increases.

Edward Woo - Wedbush Morgan Securities Inc.

In terms of price increases also by your suppliers, you mentioned that there was a little bit of increases done and you [inaudible] inventory. Is it price increases typically once a year?

Mendo Akdag

Yes.

Edward Woo - Wedbush Morgan Securities Inc.

And they're typically right at the beginning of the year?

Mendo Akdag

Yes, most of them are, yes.

Operator

Your next question comes from Kristine Koerber - JMP Securities.

Kristine Koerber - JMP Securities

With regards to the warehouse extension, has that 15,000 square feet, has that been added already? And with the extension, how much will you be able to support in sales going forward?

Mendo Akdag

It has not been added yet. We anticipate it will be added by probably January 2009, February 2009, before our next peak season.

We are doing some more automation on our fulfillment, and we anticipate that it will double our current capacity.

Operator

Your next question comes from Paul Taylor - Taylor Investment Services.

Paul Taylor - Taylor Investment Services

The long-term investment line, the auction notes, any possibility there would be an impairment there? I assume they're all paying and everything and I know everybody else has them.

Mendo Akdag

They're municipals. They're valued at 100% currently.

Bruce S. Rosenbloom

Well, just to give you an idea, as of March 31, 2008, the company had $29.5 million invested in auction rate securities, with $4.8 million classified as short-term investments and $24.7 million classified as long-term investments.

As of today, we currently have $24.7 in auction rate securities. So we actually were able to sell about $4.8 million since March 31.

Since January 1, we've been able to cash out about almost half of our position in auction rate securities. Our auction rate security investments are not mortgage based but are municipal based, and banks are still valuing those bonds at 100% of par.

Currently we don't see any valuation issues. And then for us, again, an auction failure is no different than holding these investments. Luckily, we're in a position where we don't need the liquidity and the extra interest income is a big benefit to us.

Paul Taylor - Taylor Investment Services

Your CapEx budget, I know you're doing an extension but should we expect anything different than the normal $1 million or so for this year?

Mendo Akdag

We do not have completed our plans yet for the automation. We're going to do further automation in our fulfillment center and the numbers are not nailed down yet. So it will probably be in the $1 million range is what I would anticipate, but we'll probably put something in the 10K. But the numbers have not been finalized.

Paul Taylor - Taylor Investment Services

That's $1 million additional or $1 million total?

Mendo Akdag

Yes, I would anticipate about $1 million addition for the warehouse automation. So $1 million, $1.5 million is roughly what you would be looking at for the fiscal 2009.

Operator

Your last question comes from [Kama Kava] - Canaccord Adams.

[Kama Kava] - Canaccord Adams

Just a follow up on the transportation costs. Is the cost increase you're seeing from the supplier to your warehouse or from the warehouse to the customer or both and which one is having the bigger impact based on your contracts with the transportation companies?

Mendo Akdag

Our shipments outbound from our warehouse to the customer will have the biggest impact.

Operator

At this time, we have no further questions.

Mendo Akdag

According to the American Pet Products Manufacturers Association, spending on pets in the U.S. increased by about 7% and reached $41.2 billion in 2007. The pet supplies and medicine category grew approximately 5% and reached $9.8 billion. There's a continuing increase in pet-related spending, a higher awareness of pet health, and the continued humanization of pets, integrating them into all aspects of our lives.

To capitalize on this trend, we'll be focusing our efforts on three areas - one, capturing additional market share; two, increasing reorders with personalized communication and health education content, and three, improving our current service level.

This wraps up today's conference call. Thank you for joining us.

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